Williams Mullen: Gift and Creditor Protection Planning with Virginia’s New Self-Settled Spendthrift Trust Statute

Williams Mullen: Gift and Creditor Protection Planning with Virginia’s New Self-Settled Spendthrift Trust Statute

BY: FARHAD AGHDAMI & JEFFREY D. CHADWICK

On April 4, 2012, Governor McDonnell signed Senate Bill 11 into law, which permits the creation of "self-settled spendthrift trusts" in Virginia.  A self-settled spendthrift trust is an irrevocable trust in which the grantor retains a beneficial interest, with such interest being entitled to spendthrift protection against the claims of the grantor's creditors.  In other words, through a properly structured self-settled spendthrift trust, a client may transfer assets to an irrevocable trust and maintain a discretionary beneficial interest in the trust, and the client's future creditors would be unable to reach the assets held in the trust.  These trusts, also known as "asset protection trusts," are currently available in twelve other states and abroad.

Virginia's self-settled spendthrift trust provisions will appear in new Virginia Code §§ 55-545.03:2 and 55-545.03:3.  These provisions, which will be effective as of July 1, 2012, are the product of the Virginia Bar Association's Wills, Trusts, and Estates Legislative Committee. This client alert summarizes the statutory requirements for asset protection, describes the grantor's protected beneficial interest, and illustrates how clients may take advantage of this new legislation to make lifetime gifts in trust.

Statutory Requirements for a "Qualified Self-Settled Spendthrift Trust"

Under the statute, only "qualified self-settled spendthrift trusts" will be entitled to asset protection.  A qualified self-settled spendthrift trust must meet the following requirements:

  • The trust must be irrevocable;
  • The trust must be created during the grantor's lifetime;
  • The trust must include at least one other beneficiary in addition to the grantor;
  • The trust must have, at all times, a "qualified trustee" who maintains some or all of the trust property in Virginia, maintains records in Virginia, prepares fiduciary income tax returns in Virginia, or otherwise materially participates in the trust's administration in Virginia;
  • The trust must be governed by Virginia law;
  • The trust must include a spendthrift provision, as defined in Virginia Code § 55-545.02, limiting both voluntary and involuntary transfers of the grantor's qualified interest; and
  • The grantor cannot retain a right to veto distributions from the trust.

 "Qualified Interests" Are Protected from the Claims of Creditors

Only a grantor's "qualified interest" is entitled to asset protection.  The statute defines a qualified interest as a grantor's discretionary interest in a qualified self-settled spendthrift trust to the extent that such interest is administered by an "independent qualified trustee."  An independent qualified trustee is any qualified trustee, as defined above, who is not, and whose actions are not controlled by, a person who is related or subordinate to the grantor, a person who is not a Virginia resident, an entity that is related to or controlled by the grantor, or an entity that is not authorized to engage in trust business in Virginia.  This specifically precludes persons such as spouses, descendants, parents, siblings, and employees from serving as independent qualified trustees.

Importantly, even if the grantor's beneficial interest is controlled by an independent qualified trustee, creditors will have five years from the trust's creation to bring existing claims.  Similarly, asset protection will not apply to fraudulent transfers made with the intent to hinder, delay, or defraud creditors.  Consequently, a grantor may only protect assets from the claims of future, and not existing, creditors.

Wealth Transfer Opportunity

From a pure asset protection standpoint, Virginia is not as attractive as other jurisdictions, such as Alaska or Nevada.  First, Virginia provides existing creditors with five years to set aside an existing claim, which is generally longer than the period provided by most states.  Second, the grantor may not retain the power to veto trust distributions, nor may the grantor name a family member or employee as independent qualified trustee.  And third, Virginia only protects the grantor's discretionary interest in the trust, which may cause some of the trust assets to be exposed to the grantor's creditors.  Nevertheless, a trust properly structured under Virginia law may provide clients with adequate asset protection from the claims of future creditors.

Despite somewhat limited utility from an asset protection perspective, Virginia's new provisions create excellent wealth transfer opportunities for clients and their families.  In short, clients may now make large lifetime gifts in trust for the benefit of their children and more remote descendants, yet retain a discretionary interest in such trust in case the client's financial circumstances change.  The reasons for making such gifts in 2012, including the scheduled decrease in the gift tax exemption amount from $5.12 million to $1 million per person in 2013, are detailed in a recent client alert by Farhad Aghdami, which can be accessed here.

To appreciate the impact of Virginia's new self-settled spendthrift trust statute, consider a common planning scenario:

Martha owns substantial assets and would like to reduce her estate by making a gift to a trust for the benefit of her children and grandchildren.  Martha understands that such gift will not only reduce her estate by the amount gifted, but also by all of the appreciation of the gifted assets over time.  Martha also desires to make such gifts in 2012, in order to take advantage of the limited window of opportunity to give away $5.12 million without incurring any gift tax.  Despite this, Martha is concerned that if her financial circumstances change, she may need the gifted assets at some point in the future and that she would be unable to access the funds held within the trust.  Martha decides not to make a $5.12 million gift in 2012 because she may want or need the assets in the future.  The $5.12 million appreciates over the next 10 years at 7% per year, and, at Martha's death, the assets are worth $10,071,814.  If the estate tax exemption drops, as scheduled in 2013, to $1 million with a top 55% marginal tax rate, Martha's heirs will pay $4,838,088 in estate tax.

Prior to the enactment of Virginia's self-settled spendthrift trust statute, clients who sought to make substantial gifts to their families while maintaining a financial safety net had few options.  Starting July 1, 2012, however, clients may make gifts to a qualified self-settled spendthrift trust, which could be structured as follows:

Martha creates a qualified self-settled spendthrift trust under Virginia Code § 55-545.03:3 and names Qualified Trustee to serve as initial trustee.  The trust provides that Qualified Trustee may make distributions of income or principal to or for the benefit of Children and Grandchildren for their health, education, maintenance, and support.  In addition, if an Independent Qualified Trustee is appointed, Independent Qualified Trustee may make distributions of income or principal to or for the benefit of Martha for any purpose. Assuming that Martha gifts $5.12 million into a Virginia self-settled spendthrift trust and the assets appreciate over the next 10 years at 7% per year, at Martha's death, the assets are worth $10,071,814.  There is no additional estate tax on the value of the assets in the trust, which pass estate and gift tax free to Martha's heirs.

The enactment of the Virginia statute creates a compelling opportunity for clients who wish to make gifts in 2012, but who worry that they may want or need the assets at some point in the future.

Conclusion

Self-settled spendthrift trusts create immense planning opportunities for clients and their families, particularly when combined with the favorable wealth transfer tax window of opportunity in 2012.  Quite simply, these trusts permit clients to "have their cake and eat it too" - not only can the trust serve as a vehicle to remove appreciating assets from a client's estate, it can also permit the client to retain access to the trust assets through a discretionary beneficial interest.  We are extremely excited for the opportunities this new legislation creates, and strongly believe that the self-settled spendthrift trust provides an optimal structure to make large lifetime gifts in trust.

For more information about this topic, please contact the author or any member of the Williams Mullen Private Client & Fiduciary Services Team. 


Please note: 
This newsletter contains general, condensed summaries of actual legal matters, statutes and opinions for information purposes. It is not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel. For more information, please visit our website at www.williamsmullen.com or contact John H. Turner, III, 804.420.6480 or jturner@williamsmullen.com. For mailing list inquiries or to be removed from this mailing list, please contact Julie Layne at jlayne@williamsmullen.com or 804.420.6311. 

© 2012 WILLIAMS MULLEN ALL RIGHTS RESERVED

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